By Alexander BenardAlexander Benard is managing director of Gryphon Partners, an advisory and investment firm focused on the Middle East and Central Asia. He previously worked at the U.S. Defense Department.
Eli Sugarman is a Truman fellow and senior director of Gryphon Partners. He previously worked at the U.S. State Department.
, Eli Sugarman

October 4, 2011

In about a week, the Afghan Ministry of Mines will announce that the China National Petroleum Corp. (CNPC) — the largest state-owned Chinese company — has won the rights to develop and explore several oil fields in the Amu Darya basin in northern Afghanistan.

How was CNPC able to win a tender for such a strategic resource in a country where the United States wields tremendous influence? Amazingly, one reason is that the U.S. Defense Department, whose Task Force on Business and Stability Operations, which is charged with resuscitating the economies of Afghanistan and Iraq, designed and oversaw a tender process that played to the strengths of Chinese state-owned companies over Western private ones.

The Chinese government has been actively pursuing various natural resources in Afghanistan for years. In 2007, a consortium of Chinese state-owned companies won the only other major natural resources tender in Afghanistan to date, for the massive Aynak copper deposit, thought to be worth as much as $80 billion. Over the last decade, China has sought to lock down as many natural resources as possible throughout Central Asia to fuel its skyrocketing demand for minerals, oil, and gas.

It was in this broader context that the task force took control of the oil tender in northern Afghanistan. Since 2006, the task force has been encouraging private investment, industrial development, and energy development in Afghanistan and Iraq in a bid to build sustainable economies that can survive the looming drawdown of international forces and reduction in foreign assistance in both countries.

Natural resources are an important pillar of this mission because they hold the promise of generating meaningful revenues for the cash-starved Afghan government. In 2009, the task force commissioned the U.S. Geological Survey to conduct a comprehensive review of Afghanistan’s geological riches, the preliminary results of which were announced in 2010 and showed that Afghanistan might contain more than $1 trillion in mineral wealth. This story was reported in news outlets worldwide and stoked considerable interest in Afghanistan. The task force then set out to design a process by which these resources should be tendered by the Afghan government, embedding myriad advisors — ranging from energy experts and financial consultants to lawyers — within the Afghan Ministry of Mines.

The Amu Darya tender was the first real test case. The tender covered an area of roughly 4,500 square kilometers between the towns of Sar-e-Pol and Sheberghan in northern Afghanistan, with five known fields containing an estimated 80 million barrels of crude oil — about enough to supply 11,000 barrels per day for 20 years.

Our firm assisted a Western oil and gas company that participated in the tender, but lost to CNPC. We saw firsthand how the commercial terms that would govern the development of the oil as well as the procedures for selecting the winning bidder made it all but impossible for a Western company to win the tender against CNPC.

The terms offered by the Afghan government — and designed, in large part, by the task force — did not reflect realities on the ground in Afghanistan. The key term in any production-sharing contract is the profit split, which identifies what share of oil produced belongs to the government and what share belongs to the oil company. This split is based on a variety of factors, including the quality and quantity of the oil, the technical challenge of recovering the oil, the quality of local infrastructure, and the security and political risk of the region where the oil is located. Where there is less overall risk — such as when there is plentiful, high-quality oil that is easy to access and move in a safe environment — the government receives the lion’s share of the profit oil. As risk increases, however, oil companies demand more profit oil to ensure an adequate rate of return on the capital invested.

In Central Asia, the norm is for the government to receive roughly one-third of the profit oil and for the oil company to receive the remainder. Yet in Afghanistan — one of the riskiest countries in Central Asia, with incomplete geological data and the near absence of key infrastructure — the task force pushed for a profit split that would give the Afghan government the majority of the profit oil. This was in addition to royalties and several other taxes included in the agreement, all of which are entirely atypical in Central Asia.

We provided the task force with several examples of contract terms in other Central Asian countries and repeatedly asked the task force to identify which countries served as the model for the unattractive commercial terms offered for the Amu Darya tender. The task force refused to answer our question, and the terms remained unchanged, resulting in virtually no interest in the tender among serious Western oil companies. The terms did not deter CNPC, however, which is willing to make investments in Central Asia that are not strictly profitable for the purpose of capturing resources and extending China’s political influence.

The other problem was the process, under which the company that bid the highest royalty would be designated the winner of the tender so long as it met the basic technical requirements for executing the project. It was clear from the beginning that CNPC would bid the highest royalty (especially given that the terms were unattractive to Western companies). Indeed, according to industry experts we consulted, it is common knowledge that CNPC typically bids $5 to $7 per barrel more than other interested bidders in oil tenders in which it participates. So this selection process all but guaranteed that China would win the tender.

There are other selection processes that would have been fairer to Western companies. Notably, a system that allocated a certain number of points for the royalty rate, but then also allocated points for technical qualifications, environmental track record, past performance, quality of the proposed work program, investment in the local community (including hiring of local staff), and other such factors, would have provided far more opportunity for Western companies to showcase their strengths and compete against CNPC. The task force ignored such alternate approaches — even though they were expressly permitted under Afghan law.

We urged the task force to make the terms and the selection process fairer to Western bidders, but the task force (and other branches of the U.S. government) declined to do so for two reasons. First, the task force stated that it was neutral as to the outcome of the tender; so long as the process was transparent, they did not care whether the winning company was American or Chinese. This is shocking, given that U.S. troops in Afghanistan require a steady supply of refined petroleum products to sustain their operations and that placing these resources under the effective control of the Chinese government poses a threat to these ongoing operations. In addition, the presence of Western companies in Afghanistan would help strengthen U.S.-Afghan ties and would inculcate respect for the rule of law, transparency, and other related Western business values that are important to Afghanistan’s development. Chinese companies, by contrast, are known to have a very bad track record in these areas, as well as in the employment of locals (Chinese low-wage laborers are imported).

Second, the task force argued that its main goal was to ensure that the tender generated quick revenue for the Afghan government, and CNPC offered more generous commercial terms than Western bidders. There is no doubt that the United States has a strategic interest in generating revenue for Afghanistan so that the country can become less dependent on the largesse of Western donor countries, but it also has strategic interests in promoting U.S. companies and in preventing China from capturing valuable resources. In addition, even if it were appropriate for the task force to focus singularly on generating revenue, a victory by CNPC — which is known to break contractual commitments regarding payments to host governments, move slowly in developing resources, and use subpar technologies — will not accomplish this goal. These considerations recently led the government of Kazakhstan to turn down various CNPC bids even though the commercial terms of those bids, on their face, appeared more attractive than those of other bidders. But the tender process designed by the task force did not allow the Afghans to take such considerations into account.

The Task Force on Business and Stability Operations did a disservice to Afghanistan and the United States by mismanaging the Amu Darya tender. It is, moreover, improper for the task force to spend taxpayer funds — $20 million, in total — to help China tighten its stranglehold over Afghanistan’s natural resources and, by extension, the country’s economic development. The troubling announcement that will be made this month is the perfect occasion for senior Pentagon officials and members of Congress to re-examine the activities of the task force and ensure they better align with U.S. interests.

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Alexander BenardAlexander Benard is managing director of Gryphon Partners, an advisory and investment firm focused on the Middle East and Central Asia. He previously worked at the U.S. Defense Department.
Eli Sugarman is a Truman fellow and senior director of Gryphon Partners. He previously worked at the U.S. State Department.
| The South Asia Channel |

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Zalmay Khalilzad <p>
Zalmay Khalilzad is president of Gryphon Partners, an international
advisory firm. He has previously served as a U.S. presidential envoy,
ambassador to Afghanistan and Iraq, and permanent representative to the United
Nations.
</p>
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